Explained: What is a corporate bond?

By Larissa Fernand |  24-02-21 | 

I remember the year 1997 for a number of reasons.

CNN called it a stunning bull run that left Wall Street breathless, which U.S. Federal Reserve Chairman famously referred to as “irrational exuberance”. Amazon went public that year. And J. C. Penney issued its 100-year bond.

When it comes to Amazon, this reference says it best: Amazon shares are up 168,884% since Jeff Bezos took the company public; roughly 35% compounded annually. As for J. C. Penney, the company filed for Chapter 11 bankruptcy in 2020, 23 years after issuing its 100-year bonds.

Though century bonds are relatively rare, J. C. Penney is not alone. Over the year, some of the most famous issuers of 100-year bonds have been U.S. Railroad Norfolk Southern, French utility Electricite de France (EDF), Brazilian oil giant Petroleo Brasileiro (Petrobras), Chrysler, Ford Motor Co., Walt Disney, Coca-Cola, IBM, Massachusetts Institute of Technology (MIT), Tufts University as well as other U.S. educational institutions, and Oxford University.

In India, most bonds have a 5-10 year tenure. According to a 2019 RBI report, the average non-financial private sector bond has a span of 6.8 years. I referred to these century bonds because it makes for an engaging read, and I have always been intrigued by them. The first is the assumption that the company will still be around for a century; the educational institutions most probably will. Would Amazon be around? When Disney came out with its 100-year bond, the company’s vice president of corporate communications stated that “people believe the Mouse will still be singing and dancing in 100 years”.

By the time the principal is returned, the value of that amount invested would be next to nothing. Of course, that is not our concern but that of our heirs. So the only cool factor is getting a regular return over the years, and hoping that interest rates don’t shoot up. By the way, the Disney bond offered 7.55% in annual interest, which is wonderful in today’s low-interest scenario.

So what are corporate bonds?

A company may need money for a variety of purposes. It may want to expand its business, build a new plant, buy machinery, buy new land to build a factory, or even purchase another company. One of the ways to raise money is to issue a corporate bond. Last year, as reported by Bloomberg, there was a spurt in bond issuances because companies were borrowing extra to build cash buffers to insulate themselves from financial pain caused by the pandemic.

When you buy a bond, you lend money to the company that issued the bond (issuer). In exchange, the company promises to return your money (principal) on a predetermined date (maturity date), and till it does so, it will pay you a specified rate of interest (coupon rate).

Say you invest Rs 5,000 in a 6-year bond, paying a coupon rate semi-annually of 5% per year.

  • Face Value: Rs 5,000. This is the amount you loaned to the company and it promises to return it on maturity.
  • Maturity: 6 years. This is the tenor of the bond. It is the length of time of the financial contract.
  • Coupon Rate: 5% per annum. The Coupon Rate is always tied to the bond’s Face Value. 5% of Rs 5,000 = Rs 250 per annum.
  • Since the payment is to be made semi-annually, you will receive 12 coupon payments of Rs 125 each (Rs 250 per annum).

A bond is a debt obligation. The company makes a legal commitment to pay interest on the principal and to return the principal. Whether the company makes profits or incurs losses, or its stock price rises or falls, that is irrelevant to the terms and conditions. It still has to pay the interest rate promised and return the money on the specified date.

There are two ways to invest in corporate bonds.

The first is the direct route. But there are many factors that go into selecting a bond. Rating agencies (CARE, ICRA, India Ratings, Brickworks and CRISIL) rate these bonds so that an investor can understand the risk associated with that company.

The more convenient option is to invest in a corporate bond fund. Such funds invest a minimum 80% of the corpus in AA+ and above rated bonds, which indicates high safety. These investments are diversified across companies and sectors. You can access the entire list of corporate bond funds here.

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